rd80 (97.82)

More Muni Madness

11

I’ve been spending a little time following municipal bonds lately and believe some of those markets have a good chance of being the next big trouble spot for the economy.

The great state of Illinois made a few headlines last week with a $3.7 billion taxable bond offering. These bonds are taxable because, as reported in some of the news stories, contributions to the state pension plan don't qualify for tax-free status. The proceeds from this bond sale were used to make the state's required contribution to its pension fund.

Borrowing money to fund the pension account. Sounds similar to investing on margin - what could go wrong?

According to the Wall St. Journal report on the bond sale, "Illinois officials were forced to promise a yield that is about two percentage points higher than was paid by companies with similar credit ratings in recent bond offerings." My interpretation of that is the bond markets believe IL is a worse credit risk than its credit rating would indicate.

WIFR TV from Rockford, IL reports the average rate for the bond issue was 5.56% and that the bonds have maturities ranging from 2014 - 2019. That’s getting up near junk bond yield territory for maturities in that range.

I don’t own any municipal bonds, but if I were planning to invest in some (and I’m not), I would look for a closed-end or mutual fund with an experienced management team rather than an ETF or other index vehicle. An fund tracking an index has no way to sift out anomalies like this recent IL bond yield indicating that the market thinks the bond is riskier than its rating. This is one area of the markets where active management makes sense.

I don’t believe we’ll see the full doom and gloom scenario predicted by some in the municipal markets. But, I think there’ll be some sizeable problems. And Illinois is one of the leading contenders to be the source of a sizeable problem.

Illinois pays their bills not when due, but whenever they get around to it which on average is anywhere from 8 months later to the check is in the mail isn't it ? oh snap let me check on that and get back to you.

What this means is that there are fools out there with cash who are willing to take a big risk for a higher return. When Illinois defaults on these bonds, let us not hear the administration of Gov. Pat Quinn or the bondholders beg the federal government for a bailout.

Even more troubling is where Illinois' bonds had to be sold.

Illinois tapped the taxable-debt market, where yields tend to be higher than in the tax-exempt municipal-bond market, because selling bonds to prop up sagging pensions typically doesn't qualify for tax-exempt status under the U.S. tax code, say bankers and state officials.

In other words, the bond houses that sold Illinois bonds, didn't even go to the traditional market of investors who like municipal and state bonds because they are not required to pay federal tax on their returns. Typically tax-free bonds are sold at a lower interest rate because they are tax-free, giving the investor a higher net return.

As for Illinois taxpayers, go screw yourself. Quinn is counting on the public not to understand how all this borrowing works.

Hey truth, how about inviting me to be able to blog... i guess caps has some new policy that requires someone to have to invite another to be able to create their own blogs.. so i'm stuck to simply responding until either someone established invites me or they accept my application ?

Gosh, I should have looked back one more time before going to watch TV. You sure have my invite, LORDZ. Funny thing is, nobody ever invited me. I just started blogging when I decided I wasn't getting on everybody's nerves enough just commenting. Wow. So really - they have changed it so you have to be invited?

If I were an entity that funded a pension program for retirees, I guess I'd do my darndest to make sure those retirees couldn't access quality health care! The longer they live, the more pension they collect!

@truth - I don't have all the factors that go in to state bond ratings, but IL has at least three trouble spots.

1. The late payment to vendors issue LORDZ mentions. Late last year, the state was trying to broker deals to have investment firms buy overdue accounts receivable from vendors, the marketing approach is that the 1% per month late fees make the paper basically about 12% per year. Not sure if that's still being pushed.

2. Big unfunded pension liabilities. I think IL has something a little less than 50% of its pension liabilities funded. It's one of, it not the, most underfunded state plans in the country.

3. $15 billion budget shortfall. The numbers I've seen predict the recent tax hike will raise about $7 billion of that. Not sure where the other eight's coming from.

I've gotten nearly all the information I've found on municipals from WSJ articles. If an article has an interesting point, I'll google a few keywords to try and find more. I'm sure there's a good go-to site somewhere, but I haven't run across it yet.